Lloyds' profits fell into an abyss

Lloyds Banking Group's profits cratered.

The partially state-owned bank said in is first quarter interim management statement that its pre-tax profits fell by 46% to £654 million.

Underlying profits also fell 6% to £2.05 billion.

But the biggest issue to hit the bank, which is warned the markets about in its full year results previously, was its £3 billion buyback of expensive bonds from investors - called Enhanced Capital Notes (ECNs).

It lost £800 million in costs related to ECNs.

Lloyds received £20.5 billion in state handouts between 2008 and 2009 following the credit crisis. In return, the government took a 43.4% ownership stake in the bank at the time. (As of 2015, the government has since reduced its stake to around 9%.)

It then sold "Enhanced Capital Notes," or ECNs to retail investors when the bank needed more cash instead of going back to the government cap in hand. These bonds were a crucial source of liquidity to Lloyds at the time.

Investors loved the bonds because they paid a massive 12% interest. Most interest-bearing investor products are near zero or 1% interest right now.

In December 2014, Lloyds announced that it wanted to buy back or exchange a bulk of ECNs for up to £8.4 billion. This is mainly because the bonds no longer counted towards capital requirements - the amount of liquid assets banks need to have to buffer them against another financial crisis.

If the ECNs didn't count towards capital requirements, it meant Lloyds was paying interest to investors a huge return on an asset that was just wasn't counting towards its the health of the bank. It could have those bonds liquidated into it's coffers in a way that would contribute to its bufferzone.

The Financial Times said in 2014 that Lloyds was in a position to save £2 billion in the manoeuvre.

However, after eventually buying back the bonds last year, it warned that it will incur a costs initially. But Lloyds said it should get a £900 million cash injection over the next 4 and a half years. It has chosen to redeem the bonds.

It's little wonder, after seeing Lloyds' update, why it decided to 600 jobs and closing 21 branches as part of a major restructure of the bank.

It really really needs the cash especially if it is aiming to return to the private market and shake off the last remaining parts of its state ownership.